A blog designed to provide an outlet for Jeff's and other unvarnished opinions on community financial institutions. Sometimes serious, other times not, Jeff's opinions are his own and may not represent the opinions of his esteemed employer.

Saturday, November 24, 2012

Shark Tank: Bankers' Edition

Reality shows are generally not my thing. Don’t get me wrong, I’m often subjected to the genre because I submit to family preferences. How else would I know that Emmitt Smith is quite the twinkle toes. But, while channel surfing, I discovered Shark Tank.

On Shark Tank (see the clip below), entrepreneurs pitch their ideas to a panel of angel investors, known as sharks, to win funding for their enterprise. The sharks, one of whom is Mark Cuban, the colorful owner of the Dallas Mavericks, pillory the entrepreneur with questions about their product(s) and business plan. After the Q&A, they decide if they want to fund the venture, and at what level. Watching and listening to the questions, answers, offers and counteroffers is fascinating.

I recently read a NY Times You're the Boss Blog article regarding how banks can fund small businesses. It made me think of Shark Tank. Businesses evolve through various stages. In early stages, entrepreneurs struggle to get funding. It’s generally too risky for a bank loan. So, early stage funding typically starts with owner’s capital, then to friends and family if it gets that far, then to angel investors. Banks will entertain a loan typically after a few years of successful operation. There are exceptions, however. The SBA loan program was designed to get earlier stage capital to entrepreneurs. But generally, young businesses need equity, not debt.

Many banks are headquartered or have significant presence in communities that are experiencing economic difficulties. This impacts loan quality, loan demand, growth, and profitability. But most banks remain on the sidelines when it comes to small business formation. The businesses formed today, appropriately capitalized, will be those that sustain our communities in the future. Some of the fastest growing companies today are not that old...i.e. Priceline.com, VistaPrint, Netflix, etc.

These businesses needed capital. Many top new companies are located in California’s Silicon Valley, and not coincidentally, that is where many venture capital firms are located. As traditional providers of capital, can banks participate in funding early stage ventures? I say yes because of community banks’ unique position in our communities.

But funding early stage businesses does not have to be with the traditional bank loan, or even an SBA loan. These are equity investments, higher risk seeking higher return. I think banks can sponsor their own version of Shark Tank. Not as sole investors in an angel fund, but as investors and managers of an angel fund, much like the sharks of Shark Tank. What would be bankers’ objections:

1. It is an impermissible activity… jfb response: Put it at the holding company. Many banks manage mutual funds in their trust companies, don’t they?

2. It wouldn’t be profitable… jfb response: I wonder how venture and angel funds do it? A small, $10 million fund can earn a 2% annual fee ($200,000) and 20% of the “ups” (fund returns). So if an angel fund averaged a 10% annual return (low for venture fund standards), the revenues to the manager of the fund would be $400,000 ($200,000 annual fee plus 20% of the $1 million annual return). You couldn’t manage a $10 million fund for $400,000/year?

3. We would have to turn down more businesses than fund… jfb response: True! But it would force startups to develop a business plan to chart their future and present to the sharks. Even if the venture doesn’t win the funding, the entrepreneur would have thought through the business more thoroughly. How many times do you drive by a new business that you don’t think will make it? Through this process, those that get turned down may turn their entrepreneurial spirit to a more sustainable venture, or burn with a greater desire to prove you wrong!

The benefits, in my opinion, would be:

1. Get more funding to promising startups. One of the top reasons for business failure is lack of capital.

2. Turn your community into a business incubator. Bring enough publicity to your process, you are likely to get more businesses seeking funding. Do you see having more, higher quality startups in your community as a good thing?

3. Build a sustainable future for your community. The employers of today are not likely to be the employers for the next generation in your local area. Acquisitions, changing consumer preferences, and general corporate inertia make today’s strong business into tomorrow’s dinosaur. Remember the Palm PDA? Strong, vibrant communities should always be looking to the next ventures that will sustain them into the next generation.

What do you see as advantages and disadvantages of a community bank sponsoring its own Shark Tank?

3 comments:

I always wondered why Community Banks did not take a more active role in providing venture capital for startups much like you describe. In simple terms it seems feasible and if successful these new companies would eventually require traditional bank loans for their ongoing operations.

I wholeheartedly agree! And don't forget these in-community startups will have local employees, and vendors that provide them products and services.

One other objection that a banker may pose: One way to "take out" an angel investor is a bank loan once the business has a successful operating history. The angel fund sponsoring bank may not be able to do that loan if the purpose is taking out the angel fund. But I'm not certain of this.

However, it would be short sighted to not seed new ventures for this reason. The bank's community, and therefore the bank, would greatly benefit from a successful company in their backyard.

About Me

Jeff started his banking career in the IT Department of a northeast regional bank in 1985. His banking experience includes IT, Trust, branch management, and merger integration. He has served as a consultant to the banking industry since 1997, specializing in strategy development, M&A, and profitability. He interrupted his banking career to serve in the U.S. Navy, the best Navy in the world, where he specialized in intelligence gathering against very bad people. He lives in Lancaster County, Pennsylvania with his wife and two children.